Keep Your Customers Happy but Disorganized to Prevent Buyer Power

Well-organized buyers can work together to create a strong bargaining position. How can you keep customers from establishing buyer power?

Several years ago my wife was shopping in a clothing store in Beijing when she saw a crowd begin to coalesce around a table of shirts. At first, a few customers were looking at the shirts independently but slowly they began to talk with each other and form a circle which attracted even more members. She continued to watch them and eventually the group migrated over to a cash register and began talking with a clerk. Her curiosity piqued, my wife went over to ask the group members what they were doing. One of them explained that while browsing at the table they had discovered that all of them were interested in buying the same shirt. They decided to band together and negotiate with the clerk collectively in the hopes of a better price.

It worked. Each of them received a 10% discount on their shirt purchase. This illustrates an important point for managers: you should be aware of whether your buyers can take actions to apply downward pressure on your margins. Harvard economist Michael Porter formalized this idea, called “buyer power,” in 1979.[1] “Buyer power” is separate from the competition that you face and you should be careful to distinguish the two. Even if you face little competition, if your buyers are powerful then you are in trouble. This is the flip side of “supplier power”, which I talked about last time. To be more optimistic let’s illustrate this from the buyer’s perspective and think about how one might increase your power as a buyer.

Being big certainly helps. On June 21, 2015 the singer Taylor Swift posted an open letter saying she would withhold her album “1989” from the Apple Music streaming service because Apple would not pay artists during the first three months of the service’s introduction. A day later Apple capitulated and agreed to pay all artists during the trial period (albeit at a reduced rate). Not just anyone could have pulled this off. The fact that “1989” had topped sales on Apple’s iTunes service in over 95 countries in the previous year and was the top selling album of 2014 in the US gave Swift immense power to negotiate with Apple despite its own power in the music marketplace.

Being bigger is not the only way to increase your power. It is also useful to think about how you and other buyers are organized. Iron ore is now priced based on a monthly index but in the 40 years prior to 2010 it was priced based on one-year contracts hammered out between iron ore producers and steel mills behind closed doors. Under this earlier system Chinese steel mills faced a predicament. Iron ore was controlled by the “Big Three” suppliers, BHP Billiton, Rio Tinto, and Vale, which together controlled around 70% of the seaborne iron ore market and coordinated their pricing with each other. Although collectively they represented 60% of world demand for iron ore, Chinese steel mills were highly fragmented with over 300 firms leaving them in a difficult bargaining position vis-à-vis the “Big Three.”

How did the Chinese steel mills handle this? With some help from the government they increased their buyer power through better organizing themselves. With the exception of a brief period in 2009,[2] negotiations on behalf of all Chinese steel mills were conducted by Baosteel, China’s largest mill. Just like the customers in the clothing shop, the steelmakers decided they would get a better price if they banded together than if they negotiated separately. This tactic prevented the “Big Three” from playing one mill off the other. This was done not only with the government’s blessing but with its active intervention with the goal of obtaining better prices for domestic steel producers (in other contexts one must be careful to not run afoul of antitrust rules which often apply to such attempts). This approach helped bring an end to the secretive negotiations that benefited the “Big Three” and led to the current system of more transparent pricing.

As a seller what can you do to counter these tactics? To keep a particular buyer from becoming too large you might give price breaks or extra services to upcoming buyers to build them up as a counterweight. To prevent your buyers from organizing tailor your product to appeal to different buyers. It is much more difficult for buyers to agree and coordinate when they are each buying an individualized product. While this is difficult with iron ore, very different shirt styles might have led the shoppers that my wife observed to different tables and prevented them from banding together in the first place.

[1] This was described in his article “How Competitive Forces Shape Strategy,” Harvard Business Review, March-April 1979 and his book Competitive Strategy, Free Press, New York, 1980.

[2] During this brief period, the China Iron and Steel Association negotiated for the Chinese mills.

About Brian Viard

Prof Brian Viard is Associate Professor of Strategy and Economics at Cheung Kong Graduate School of Business. He explores the workings of economics in everyday life and business in China through this column.

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